Improving Student Loan Administration and Disclosure Practices

Introduction

Today, tens of thousands of young people are mortgaging part of their future with student loans in order to obtain a higher education. In some cases, these students do not receive full disclosure concerning repayment terms, creating long-term hardship. To determine the facts, this paper provides an overview of government student loans and examines how the different actors on the student loan side are involved with helping student borrowers—and how those actors must be held to a certain standard. The problem is that student loan representatives are not revealing repayment options or answering questions when students call. Therefore, the purpose of this study is two-fold: (1) to demonstrate that there is in fact a duty for these actors to provide full disclosure, as required by controlling legislation, and (2) to identify potential outcomes in the event student borrowers file suit in response to violations of that duty. These issues have assumed new importance today because the stakes are particularly high: college tuition costs are rising, students are taking on more debt, and, in turn, more risk.

Background and Overview

Education loans are long-term funds that provide students and parents with the resources they need to pay for educational expenses. When people accept student loans, they are legally obligated to repay them according to the terms of the promissory note. Optimal loan arrangements for students and their parents are provided by Federal Direct Loans, which are available irrespective of the amount of family income involved; however, loans with the best terms are offered to students who are able to demonstrate financial need. Generally speaking, federal loans provide students and their parents with superior terms compared to the majority of private or bank loans. For instance, the majority of bank loans come with high interest rates and do not contain the same provisions for deferment of payment that federal loans offer. By contrast, Federal Direct Loans can be deferred for repayment until borrowers are enrolled less than half time as undergraduates or graduate students. The U.S. Department of Education has a number of loan servicers that administer student loans for the William D. Ford Federal Direct Loan (Direct Loan) Program as well as for loans originally completed pursuant to the Federal Family Education Loan (FFEL) Program that are currently being serviced by the U.S. Department of Education.

Despite the advantages of Federal Direct Loans, the Consumer Financial Protection Bureau (CFPB) has been encouraging lawmakers to revise the existing disclosure requirements of private student loan servicers to align their services with comparable reforms that have been implemented in the mortgage industry. In this context, disclosure has been recognized as an essential element of consumer protection policy in financial services. A salient example of these trends is the Truth in Lending Act (TILA), passed by Congress in 1968, which requires that lenders provide consumers with disclosures concerning rates and terms for mortgages, credit cards, and other types of consumer loans. A number of other laws also include consumer disclosures as a fundamental component of their provisions, including the Real Estate Settlement Procedures Act, the Consumer Leasing Act, the Electronic Fund Transfer Act, and the Truth in Savings Act. Over time, these laws have been amended and new requirements added. Recent federal legislation has required the revision or addition of disclosures through provisions of the Mortgage Disclosure Improvement Act, the Higher Education Opportunity Act, the Helping Families Save Their Homes Act, and the Credit Card Accountability Responsibility and Disclosure Act.

Likewise, the U.S. Congress placed further emphasis on the centrality of providing American consumers with timely information concerning their financial transactions by passing the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010, which established the independent Consumer Financial Protection Bureau (CFPB). The Dodd-Frank Act stipulates that the majority of the disclosure and rulemaking responsibilities for consumer credit and deposit products—previously the responsibility of the Federal Reserve Board and other federal agencies—were consolidated under the purview of the CFPB.

Despite the fact that some level of disclosure is routinely provided by most financial services organizations, these legislative initiatives have been important for improving the overall quality of such disclosures. As Hogarth and Merry emphasize, "While many financial service firms provide product information in the absence of mandatory disclosure requirements, the presence of these requirements imposes common standards of terminology, presentation, and calculation of relevant figures that can aid consumers in making comparisons between products and providers." This approach is a far cry from the types of disclosure practices that existed in the United States in the early 1960s, when disclosures for interest rates on consumer credit products were primarily controlled by state law and a wide array of standards were used by lenders. The Truth in Lending Act addressed this problem by creating a common set of national disclosure standards concerning the respective costs of different types of loans.

The CFPB has reported that students with private loans who are attempting to pay off or reduce their loan amounts are being deceived into paying higher fees with longer repayment terms that inevitably damage their credit ratings. The CFPB has expressed increasing concern over the growing numbers of private student loans and their corresponding default rates. According to American Banker, "The CFPB—which has made aggressive steps in 2013 to monitor the private student loan market—recently said that there are 7 million student loan borrowers who have defaulted in a market with more than $1.2 trillion in outstanding student loan debt." By any measure, $1.2 trillion represents an enormous investment in America's future, but this future is threatened by the potential default of many students who find themselves unable to repay these loans when they come due.

Despite the fact that the majority of student loans continue to originate with the federal government, students who assume responsibility for private loans are placed at a disadvantage compared to federal loan borrowers, because private loans are typically charged at higher and variable interest rates. In fact, the majority of recent complaints from student borrowers have related to being manipulated by loan servicers in ways that cost them even more money. For instance, American Banker reports that "many of the 3,800 private student loan complaints that the CFPB reviewed from October 2012 through September were related to payment processing issues, particularly when the borrower tried to pay off the debt early or set up a certain periodic payment structure but incurred a fee to do so."

The CFPB has also reported that borrowers with more than one student loan have been unable to direct additional payments toward the loan carrying the highest interest rate; rather, their payments have been distributed equally across all loans, thereby extending the loan repayment period. In reality, these practices are understandable from the servicer's perspective because the longer students take to pay off their loans, the more money loan servicers generate—even though paying off a student loan as early as possible is in the best interest of borrowers. This practice represents a growing concern for policymakers because the provisions of the amended Truth in Lending Act of 2008 prohibit the imposition of penalties for the early repayment of private student loans. In other cases, students have been charged extra fees when they tried to modify or reduce their monthly payment arrangements, and in yet other cases their payments have been distributed among different loans in ways that result in additional fees. As American Banker reports, "In certain cases, student loan servicers applied payments in such a way that struggling borrowers did not meet the minimum payment on multiple loans, incurring multiple late fees."

In order for students to make an informed judgment concerning their capability of repaying student loans in the future, they must be able to calculate their chances of actually finishing a degree program and must be able to fully comprehend the terms of their loan repayment. Because student loans represent such a major investment in the future, it is vitally important for borrowers to receive full disclosure concerning the terms of repayment and any potential hidden charges that may be assessed.

Unfortunately, the CFPB confirms that loans continue to be made to students with minimal analysis of their potential ability to repay, and these loans are often made without cosigners to guarantee repayment. As American Banker concludes, "Unlike federal loans, there is often no safety net built into these loan programs, such as loan forbearance or modification rights for those who are unable to make payments after graduation." Taken together, it is clear that the student loan process is fraught with loopholes and provisions that often place borrowers at a disadvantage, as discussed further below.

Controlling Legislation for Student Loans

Like automobile loans or home mortgages, federal student loans are authentic loans that must be repaid even in cases where borrowers experience financial problems. Moreover, student loans cannot be forgiven if students fail to obtain the degree they were seeking, except in those cases where failure to complete a degree program resulted from school closure. Student loans can be forgiven, however, in cases where students die or become permanently disabled. Otherwise, students must repay each of their loans pursuant to the repayment schedule provided by the Direct Loan Servicing Center. The grace period for deferred payment of student loans ranges from 10 to 25 years, depending on the total amount borrowed and the provisions of the repayment plan. Although plans are in place to provide students and their parents with the additional information they need to make an informed decision concerning loan amounts and repayment terms, borrowers at present are still at a disadvantage with respect to these issues.

At present, the law rules out loan forgiveness except under special circumstances such as death, permanent and total disability, bankruptcy (in some cases), school closure prior to completion of an educational program, or entry into a designated public service career. The U.S. Bankruptcy Code at 11 U.S.C. 523(a)(8) provides an exception to bankruptcy discharge for education loans. The types of student loan forgiveness, cancellation, and discharge are summarized below.

Types of Student Loan Forgiveness, Cancellation, and Discharge

The following types of forgiveness or discharge apply across Direct Loans, Federal Family Education Loan (FFEL) Program Loans, and Perkins Loans (where indicated): Closed School Discharge; Total and Permanent Disability Discharge; Death Discharge; Discharge in Bankruptcy (in rare cases); False Certification of Student Eligibility or Unauthorized Payment Discharge (Direct and FFEL); Unpaid Refund Discharge (Direct and FFEL); Teacher Loan Forgiveness (Direct and FFEL); Public Service Loan Forgiveness (Direct Loans only); and Perkins Loan Cancellation and Discharge, including Teacher Cancellation (Perkins Loans only).

The purpose of 20 U.S. Code § 1091a—Statute of Limitations and State Court Judgments—is to provide assurances that student loans and grant overpayments are repaid irrespective of any federal or state statutory, regulatory, or administrative limitation on the period within which debts may be enforced. Moreover, Section (b) of 20 U.S. Code § 1091a stipulates that, notwithstanding any provision of state law to the contrary: (1) a borrower who has defaulted on a loan made under this subchapter shall be required to pay, in addition to other charges, reasonable collection costs; (2) in collecting any obligation arising from a loan made under Part B of this subchapter, a guaranty agency or the Secretary shall not be subject to a defense raised by any borrower based on a claim of infancy; and (3) in collecting any obligation arising from a loan made under Part D, an institution of higher education that has an agreement with the Secretary pursuant to section 1087cc(a) shall not be subject to a defense raised by any borrower based on a claim of infancy.

Beyond the foregoing, the College Cost Reduction and Access Act of 2007 (P.L. 110-84, 9/27/2007) included income-based repayment as an alternative within both the Direct Loan and the Federal Family Education Loan (FFEL) programs. According to Kantrowitz, "This repayment plan bases monthly loan payments on 15% of discretionary income, with discretionary income defined as the amount by which adjusted gross income exceeds 150% of the poverty line. After 25 years in repayment, the remaining amount owed is forgiven." These arrangements provide lower monthly payments compared to the income-contingent repayment plan. In addition, the application of the poverty line at 150% as a threshold means that repayment plans are congruent with the same standards applied to bankruptcy fee waivers. According to Kantrowitz, however, "It should be noted that the U.S. Supreme Court upheld the government's ability to collect defaulted student loans by offsetting Social Security disability and retirement benefits without a statute of limitations in Lockhart v. United States (04-881, December 2005)."

In Lockhart v. United States, a portion of Lockhart's Social Security payments were withheld beginning in 2002 to repay his federally reinsured student loans that had become overdue by more than 10 years. The petitioner filed suit, maintaining that the Social Security withholdings were barred by the 10-year statute of limitations pursuant to the Debt Collection Act of 1982, 31 U.S.C. § 3716(e)(1). In addition, the Social Security Act generally exempts Social Security and other benefits from withholding or other legal processes. 42 U.S.C. § 407(a) stipulates that "[n]o other provision of law … may be construed to … modify … this section except to the extent that it does so by express reference," § 407(b). Pursuant to 20 U.S.C. § 1091a(a)(2)(D), the Higher Education Technical Amendments of 1991 eliminated time limitations on lawsuits targeted at collecting overdue student loans, and in 1996 the Debt Collection Improvement Act made Social Security benefits subject to withholding "[n]otwithstanding [§ 407], 31 U.S.C. § 3716(c)(3)(A)(i)." The District Court initially dismissed the petitioner's complaint and the Ninth Circuit affirmed. The Supreme Court also held that the federal government is authorized to withhold Social Security benefits in order to collect a student loan debt that has been overdue for more than 10 years.

In addition, the Court held that: (1) the Debt Collection Improvement Act makes Social Security benefits subject to offset, providing the express reference that § 407(b) requires to supersede the anti-attachment provision; (2) the Higher Education Technical Amendments remove the 10-year limit that would otherwise bar offsetting the petitioner's Social Security benefits to repay his student loan debt—and although debt collection by Social Security offset was not authorized until five years after this abrogation of time limits, the plain meaning of the Higher Education Technical Amendments must be given effect even though Congress may not have foreseen all of its consequences, Union Bank v. Wolas, 502 U.S. 151, 158; and (3) though the Debt Collection Improvement Act retained the Debt Collection Act's general 10-year bar on offset authority, the Higher Education Technical Amendments retain their effect as a limited exception to the Debt Collection Act time bar in the student loan context. The Court declined to read any meaning into a failed 2004 congressional effort to amend the latter Act to explicitly authorize offset of debts over 10 years old. See, e.g., United States v. Craft, 535 U.S. 274, 287.

Conversely, the Health Care and Education Reconciliation Act of 2010 (P.L. 111-152, 3/30/2010) introduced a revised version of income-based repayment that reduces monthly payment terms by one-third—to 10% of discretionary income—and provides for the forgiveness of remaining student debt after 20 years in repayment instead of 25 years, effective July 1, 2014. However, students who had previous federal student loans as of June 30, 2014 are not eligible for these revised income-based repayment terms.

To help reduce student loan default rates, the Consumer Financial Protection Bureau and the Department of Education have encouraged colleges and universities to employ a standardized model financial aid disclosure form that provides students with the ability to compare different loan rates and identify associated risks and costs. In many cases, parents are confronted with a confusing array of loan terms and conditions, causing some to finance college expenses with credit cards—a far more expensive option compared to student loans. Furthermore, students remain unable to accurately determine how much debt is appropriate for them because financial aid award letters fail to provide repayment estimates. In sum, students are faced with a bewildering array of rules and regulations that place them at a disadvantage during a critical period in their lives.

Conclusion

The research was consistent in showing that loan servicers involved with helping borrowers with their student loans need to be held to a certain standard. The problem that is occurring is that student loan representatives are not revealing repayment options or answering questions when students call. With billions of dollars in student loans already in default and the potential for billions more in the future, the administration of federal and private student loans has assumed new importance and relevance. The student loan program is sufficiently important to the nation's interests that it is vital to retain the program's purpose, but changes need to be made with respect to the provision of full disclosure by lenders. A potential solution could be to prevent the government from collecting student loans in those cases where its representatives failed to make full disclosure concerning loan repayment conditions and, like the CFPB lawsuit against ITT Educational Services, Inc., impose additional financial penalties including civil fines.